October 13, 2003

Around Every Silver Lining There Is a Dark Cloud

Stephen Roach thinks that we have already seen the fastest growth the U.S. economy will see for quite a while. He's very smart, and very thoughtful:

Morgan Stanley: ...In the case of the US, a significant portion of the current growth spurt appears to have borrowed from the future. At least, that's the verdict that can be taken from what we estimate to have been close to a 25% annualized growth in durable goods consumption in the two middle quarters of 2003 -- the sharpest back-to-back quarterly gains in this category since the early 1970s. With consumer durables now having risen to what we estimate is a record 11.4% share of real GDP in 3Q03, nearly two full percentage points above the 9.5% portion prevailing at the onset of the last recession in early 2001, there's little reason to believe that the recent surge represents a recouping of long-deferred, or pent-up, demand. Instead, it was probably more of an artificial boost reflecting the impacts of the recent tax cut, aggressive vehicles sales incentives, and the lagged effects of yet another surge of home mortgage refinancing activity. Inasmuch as durables are long-lasting items that are purchased at infrequent intervals, I would conclude that the spending burst of mid-2003 undoubtedly borrowed from gains that would have otherwise occurred in subsequent quarters.

That could be a big deal for the US growth outlook. Surging expenditures on consumer durables accounted for about 2.0 percentage points of annualized real GDP growth, alone, over the past two quarters. To the extent that such an impetus did not reflect the fundamentals of pent-up demand, a payback of like magnitude would not be surprising. Historical experience does, in fact, tell us that's the norm after any spike in durables spending -- let alone the excessive one of the past two quarters. Since 1960, there have been 16 instances of excessive growth in durable goods consumption (defined as an annualized growth contribution exceeding 1.5 percentage points of real GDP) that contributed, on average, 2.2 percentage points of annualized real GDP growth; in the two quarters that followed, the growth contribution slowed dramatically, on average, to just 0.1 percentage point. To the extent such a payback is likely after the current spending burst, it could act as a sharp depressant on overall demand growth in subsequent quarters. That development, in the context of a lingering jobless recovery, could raise serious questions about the staying power of America's current cyclical resurgence.

There's a certain irony in such a possibility. Eager to jump-start the US economy prior to the upcoming presidential election, the Bush Administration focused on front-loaded tax cuts that were designed to have maximum impact in 2004. "Spring-loaded" was the term used by Treasury Secretary John Snow to describe the growth potential of these measures. Well, the White House may have gotten more than it bargained for. The risk, in my view, is that the policy induced stimulus occurred sooner than expected in 2003...

Posted by DeLong at October 13, 2003 08:23 AM | TrackBack


Well, just to be reeeeaaalllly picky, I think the Dark Cloud is usually *inside* the silver lining, not around it.

Can you tell Canada has a holiday today, and I don't have much to do?

Posted by: Tom Slee on October 13, 2003 11:50 AM

With that information, where does one look for investment opportunity. Given a falling GDP for the next 2 years means it seem that buying into the stock market at this time would be a bad idea. And buying into the bond market would be a bad idea because of the pressure of rising interest rates. And real estate is overbuilt (apartment houses appear to be durable goods).
This economy is trully depressing.

Posted by: PT Martin on October 13, 2003 12:19 PM

Wait, I'm confused. The Bush tax cuts were front loaded? I thought that one of the complaints, at least with the first cut, was that it was poorly designed for stimulus, as it deferred many of its cuts until later years.

Posted by: Jeff on October 13, 2003 01:09 PM

The latest 2003 tax cuts including incentive for business investment for capital equipment were more front loaded than previous packages. The front loaded $300 rebates were only put in the 2001 tax cuts at the insistance of the Democrats. However, the overall tax cut package including the 2001 tax cuts have the most of the cuts phasing in in the future. For instance, phasing out the estate tax (a real whopper) is only completed in 2010.

Posted by: bakho on October 13, 2003 01:27 PM

There are investment opportunites in large oils and public utilities here and abroad. The Pacific offers opportunites and there are selective Europe opportunites. Still, an expensive market for stocks and bonds.

Posted by: anne on October 13, 2003 01:48 PM

>>front loaded>>

The cuts feature a small amount of front loaded stimulus, and a huge back end cost, most of which goes to those who don't have a high marginal propensity to spend.

They've combined high cost with low stimulus. Hard to do much worse.

Posted by: richard on October 13, 2003 02:39 PM

PT Martin asks what investment opportunities exist in this complicated period. Anne mentions big oil, public utilies and investments abroad.

I wouldn't disagree with her, but would propose that we are entering a period much like the 1970s, with large deficits, declining economic competitiveness, war, economic stagnation and likely inflation. Unlike the 1970s, we have an administration that favors recession over inflation and that has a weak grasp on economic principles, not to mention reality.

In the 1970s, people invested in hard assets did reasonably well, while those who invested in stocks and bonds did not. Natural resource stocks, such as oil, do provide some degree of hedge against inflation, as do industries that have pricing power.

There are funds that are closely correlated with currency. I recommend Business Week's fund screen. While the decline of the dollar against the Euro has probably run much of its course, the yen has stayed stubbornly low. The laws of economics should take hold sometime in the next year of so.

Another approach is short-terming the market. While financial analysts are correct to point out that most day traders lose money, because markets are fairly efficient at pricing in information, there are always companies that are undervalued or overvalued. One can profit either way.

While that most commonly obtains with small companies, where there isn't so much pricing information, it was also obvious with (for example) Citigroup in the summer of 2002. A clearly political attack was mounted on the company and the stock dropped into the mid 20s. If one understood the political nature of the attack, it was fairly obvious that the stock would rise. If one bought at 27 and sold at 45, one did well.

In that sense, we are in an era somewhat like the 1920s, in which stocks are "boomed" and "busted". If one learns to read the signs, there is money to be made. The risk is higher.

One final investment style, not for the faint of heart: direct investment in high technology. Periods of recession often help small business at the expense of big business. Interest rates are lower, returns from blue chips are low so people are willing to take some risk, and unemployment allows small companies to snap up talent that would be otherwise unavailable. Great things are done at the grassroots while the majors restructure.

Posted by: Charles on October 13, 2003 09:25 PM


Posted by: Dick Durata on October 13, 2003 11:39 PM

PT: Investment opportunities? I'm betting on China. And US govt. bonds. I don't agree that deficits will be driving yields up soon - that effect should be swamped by overall malaise, keeping them low.

And I've only been wrong about 50% of the time. ;)

Posted by: andrew on October 14, 2003 01:59 AM

There should be a rule that anyone reading Mr. Roach should then immediately read Mr. Berner.
Both men have the same facts, it's the interpretation and resulting judgements that separate the two.

Posted by: Jon A on October 14, 2003 04:17 AM

In handicapping Roach vs Berner, one probably needs to wait till at least Q1. A look at personal spending data for Q3 shows that the biggest boost to durable goods spending came in July (+3.3%), though August was also quite nice (+2.8). Data available so far for September make it look even softer. That means the base from which Q4 will start will make Q4 sales of durables look weaker than if the pattern in Q3 had been one of acceleration. Roach is probably going to look right in the Q4 GDP data, even if he is proven wrong in the longer term.

As too investment opportunities, bonds in particular, did anybody else read Poole saying that the Fed may have to keep real interest rates higher in a high productivity environment than would otherwise be the case, in order to prevent an upward creep in inflation? A little help, please? I thought, and by the record of recent FOMC statements, apparently the majority on the Board think, that productivity gains mean less inflationary pressure. What gives?

Posted by: K Harris on October 14, 2003 06:39 AM
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